Canadian Utilities (TSX: CU) is a Calgary, Canada-based multiline utility company. In communities around the world, the group is engaged in Electricity (electricity generation, transmission, and distribution); Pipelines & Liquids (natural gas, transmission, distribution and infrastructure development, energy storage and industrial water solutions); and Retail Energy (electricity & natural gas retail sales) businesses. The company has total assets of CAD 20 billion, with approximately 4,600 employees. The group has electric powerlines network of 75,000 kms, Pipelines network of 64,000 kms with a power generation capacity of 244MV, water infrastructure capacity of 85,200m3/d, natural gas storage capacity of 52PJ and Hydrocarbon Storage Capacity of 400,000 m3.

Investment Rationale

• Solid Fundamentals: The company has recorded strong financial performances over the past ten years. The company has consistently reported an EBITDA margin above 35%, operating margin above 25%, Net Margin above 10%, ROE above 10% (except FY15 and FY17). The company is consistent in free cash flow generation and have a decent dividend payment track record as well. Further, the company’s EBITDA margin of 51.5% in the Q1FY20 was significantly higher than the industry average of 38.6%. 

Canadian Utilities, EBITDA Margin (FY10-FY19). Source: Refinitiv (Thomson Reuters) 

• An Income Play with Track Record of Consistent Dividend Payment: At the last traded price of CAD 32.13 (as on June-19-2020), the company was offering a lucrative dividend yield of 5.42%, which is quite decent given the falling yield income on the sovereign bond across the board. Further, the Company's 5.42% dividend yield was approximately 10.22 times of the Canada 10 Year Benchmark Bond Yield of 0.53%, and 1.43 times of the TSX 300 Composite Index's average dividend yield of 3.77%. Moreover, the consistent free cash flow generation ability of the group allowed it to distribute a dividend to its shareholders since 1972. 

Track Record of Dividend Growth (1972-2020). Source: Company Reports

 

• Strong Balance Sheet: The company has a strong balance sheet with total assets worth CAD 20.12 billion and total liabilities of CAD 13.23 billion at the end of the Q1FY20 (ended on March 31^st, 2020). The Long-term Debt to Total Capital ratio of the company at the end of Q1FY20 stood at 52.4%, which is manageable, given the interest coverage ratio of 2.77x. Also, the company has an investment-grade credit rating, i.e. "A-" rating by Standard & Poor (S&P) and "A" rating by DRBS Ltd. Further, the company's cash and other short-term investment has surged to CAD 992 million at the end of Q1FY20, as compared to CAD 529 million at the end of the Q1FY19.

5-year Quarterly Cash and Short-term Investments Position. Source: Refinitiv (Thomson Reuters)

 

• Risk Associated with Investment: The company's business is exposed to a variety of business and financial risks. The outbreak of COVID-19 is also posing a risk to company's operations, and these risks include a decline in the consumer demand, increase in operating costs, interruption of the project work. The credit risks associated with the business are customer non-payment and change in the timing of cash flows. However, in the first quarter of FY20, the company's operations, financial position and performance have not been impacted significantly by COVID-19 pandemic.

 

Q1FY20 Result Highlights

During the quarter under consideration, the group's revenue stood at CAD 885 million, which was approximately 26% lower against the CAD 1,189 million reported in the same quarter of the previous financial year. The decline in revenue was primarily on account of foregone revenue post divestment of the Canadian fossil fuel-based electricity generation portfolio in the third quarter of the previous financial year. Further, revenue from Alberta PowerLine (APL) construction activity during the Q1FY20, followed by the sale of APL in the Q4FY20 also contributed to the lower revenue reported by the company in the first quarter of FY20. However, this was partially offset by an increase in the Alberta regulated rate base. The group's adjusted earnings stood at CAD 179 million as compared to the CAD 200 million reported in the corresponding previous quarter. Lower earnings were mainly driven by the sale of Canadian fossil fuel-based electricity generation portfolio in the third quarter of the previous financial year.

Source: Company Results (Q1FY20)

During the quarter, the company generated CAD 466 million as funds from operations, which was CAD 85 million lower against Q1FY19. The decline was driven by the twin effect of the sale of the Canadian fossil-fuel-based electricity generation portfolio and the timing of transmission costs in Electricity Distribution which would be recovered in future periods. At the end of Q1FY20, the company’s cash balance stood at CAD 1 billion, which was CAD 23 million higher on a sequential basis. Further, the company’s capital investment during the period under consideration stood at CAD 259 million, which was approximately CAD 56 million lower against the same quarter of FY19.

Dividend

As on 31 March 2020, the board of directors have declared an interim dividend of CAD 0.4354/share for the second quarter of FY20, which was higher than the dividend of CAD 0.4227/share in pcp.

COVID-19 Impact

Utilities: On March 18, 2020, the government of Alberta announced a 90-day Utility Bill Deferral Program. In which residential, commercial and farm utility consumers were given the option to defer payment of their bills considering the financial pressures arising from the COVID-19 pandemic.

• Electricity Distribution: There was no material impact of the COVID-19 on the group's revenue in the first quarter of 2020, and the segment is expected to remain resilient. The segment operates in a price indexing mechanism for the setting of the rates under Performance-Based Regulation, and the current rate structure utilizes a range of methods to restrict the exposure to lower demand from industrial and commercial customers. However, the company is closely monitoring the potential impact in terms of change in demand from industrial and commercial customers for the future.
• Natural Gas Distribution: The group do not see any material change in the FY20 revenue, as the segment operates on a revenue mechanism under Performance-Based Regulation, which provides adjustments on future revenue variances associated with changes in volumes or customer bases. However, the change in the future customer base may hurt the revenue stream, though the majority of customers are residential, and are not expected to change significantly.

Energy Infrastructure: COVID-19 pandemic did not have a material impact on the performance in the first quarter. However, Lower oil prices and lower oil demand may have an unfavourable impact on energy storage, going forward.

Top-10 Shareholders

The top 10 shareholders have been highlighted in the table, which together forms around 13.67% of the total shareholding. T.D. Asset Management Inc.  and RBC Global Asset Management Inc. holds the maximum interests in the company at 2.68% and 2.03%, respectively.

Source: Refinitiv (Thomson Reuters)

Stock Performance & Technical Analysis

At the time of writing (as on 19-June-2020, after the market close), shares of CU traded 0.53% higher at CAD 32.13. In a year over period, the company’s shares have registered a 52W High price of CAD 42.98 as on 05-March-2020 and a 52W Low of CAD 25.25 as on 23-March-2020. At the last closing price, the company’s shares traded approximately 29.7% lower against its 52W high price level and approximately 27.2% higher against its 52W lower price level.

1-year price performance (as on 19-June-2020, after the market close). Source: Refinitiv (Thomson Reuters)

Further, despite an 18% decline in the price on a YTD basis, the short-term trend is favourable in the stock as in the past 3-Months, the group’s shares were up by 12%. The stock was up by 3% on MTD basis and traded 4% higher in the past five trading sessions.

Also, at the last closing price, the company’s shares traded above the short-term crucial support level of 5-day, 10-day, 20-day and 30-day simple moving averages, a positive short-term price trend. The 14-day and 9-day Relative Strength Index (RSI) also hovering in a neutral zone.

Also, the stock has developed a strong support level at CAD 29.37 and at the last traded price, the shares traded approximately 9% above its near-term support level. The prevailing price trend is moving towards the long-term average, a positive trend.

Note: All forecasted figures have been taken from Refinitiv (Thomson Reuters). 

Stock Recommendation The company's robust, resilient business model has restricted impact of COVID-19 on the group's performance. Further, the group's performance was decent in the first quarter of the financial year 2020. The company's free cash flow yield stood at 6.8%, which provide a greater margin of safety to the existing and potential shareholder of the company, as higher free cash flow generation implies strong financial health of the company and provide sufficient headroom to manage business smoothly regardless of the economic cycle. Further, the company is offering a lucrative dividend yield of 5.42%, which is quite decent, given the falling yield income on the sovereign bond yield across the board. Moreover, the consistent free cash flow generation ability of the group allowed it to distribute dividend consistently to its shareholders since 1972. Also, the short-term technical is moving in the favour, with last traded price was above the crucial short-term moving averages of 5-day, 10-day, 20-day and 30-day.

Therefore, based on the above rationale and valuation done using the above methodology, we have given a "Buy" recommendation at the closing price of CAD 32.13 (as on 19-June-2020), with lower double-digit upside potential, based on the NTM EV/EBITDA multiple of 11.54x, on the FY20E EBITDA. We have considered Emera Inc (TSX: EMA), Hydro One Ltd (TSX:H), and Fortis Inc (TSX: FTS) etc., as a peer group for comparison purpose.

*Recommendation is valid on 22 June 2020 price as well.

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